| |
SVH Tracker - August 10, 2016: Recommendation Strategy for Serengeti Resources Inc
 Serengeti Resources Inc was recommended a new Good Relative Spec Value Buy at $0.145 on August 10, 2016 based on the gold-copper optionality of the Kwanika project in British Columbia and the exploration discovery potential suggested by the Northwest Deep IP target beneath the existing Central Zone. In light of the recent quickening of the resource sector bull market since the reversal of a five year bear market in late January 2016, and several fundamental developments that have rescued Serengeti from a zombie junior fate, the stock should be trading in the $0.20-$0.30 range where the optionality value of the existing Kwanika gold-copper resource is fair, and where the bluesky potential for a nearby "under cover" discovery that eclipses the existing Central zone is available for free. Serengeti has 92.3 million shares fully diluted, and assuming the new farm-in partner spends $8.2 million over the next 3 years to earn 35%, the implied value for the flagship Kwanika project is $21 million at $0.145, equivalent to the amount that has been spent on the project since 2007. The Kwanika project as portrayed in a 2013 PEA is worthless at the current prices of $2.18/lb copper and $1,347/oz gold even after adjusting for the decline of the Canadian dollar from 0.95 to 0.77 USD per CAD. The new farm-in partner is a South Korean entity seeking a long term supply of copper concentrates in a secure jurisdiction. The option deal, which took nearly two years to consummate, enables Daewoo to earn 35% for an additional investment that represents 30% of the total capital that will have been invested in the exploration of Kwanika. It is unusual in that it accepts a minority interest that allows a bigger mining company to buy out Serengeti and develop/operate a mine, allows Serengeti to collect the BC tax credit on exploration expenditures, and involves a firm $1.2 million commitment to earn 5%, and another firm commitment decision in early 2017 to spend an additional $7 million to earn 35%. Meanwhile Serengeti has cleaned up its balance sheet with a $660,000 private placement at $0.10 from investors betting that Kwanika is much more than an old story being hitched to the emerging resource sector bull market.
Spec Value Hunters looking for an arbitrage on the resurgence of a former zombie junior and exposure to the joys of an exploration discovery do not have time to watch Serengeti from the sidelines. The junior initiated a 3 hole drill program at the end of July 2016 which will put the junior within striking range of a new discovery by early September. The first hole will likely be a zinger that may stampede the market in so far that it fails to recognize that this is a multi-purpose hole which will cut through the established high grade mineralization while also testing the up plunge and down-dip edges of the Central Zone. The upper and lower ends of this hole will represent new information while the flashy middle will help with the company's plan to establish a high grade underground mining focus for the Central Zone. The second hole will be a vertical hole that seeks to expand the down-dip extent of the Central Zone to the north. This hole will be helpful if it expands the high grade Central core, but it will also help establish the geological context for interpreting the results of the third hole which will test the Northwest Deep IP anomaly beneath the depth limit of earlier holes. The first two holes are for the benefit of Daewoo which wants to rethink the grade and tonnage assumptions of the 2013 PEA. Hole 3 is a free lunch for Daewoo and shareholders which, if luck is on Serengeti's side, would establish the presence of a very large gold-copper enriched zone to the north of the Central Zone beneath andesite cover rocks that yielded disappointment during the 2007-2009 discovery delineation campaign. Admittedly the IP chargeability anomaly may simply reflect barren pyritic sulphides, but the low grade zinc halo within the overlying andesites allows speculation that a hydrothermal system driven by a deeper intrusion unrelated to the Central Zone was pregnant with copper and gold that dropped out below the 400 m limit of the 2007-2009 drilling. Spec Value Hunters need to be on board before this hole hits its 750 m target depth because the first hole could make the stock sufficiently expensive so that exposure to the bluesky is no longer a free lunch. I do not expect a barnburner intersection from hole #3, but I am looking for evidence such as phyllic and potassic alteration along with stockworking that the Northwest IP anomaly is a very real exploration target.
There is a serious degree of urgency to this recommendation because Serengeti is currently suffering from a market perception that Kwanika is an old story management is recycling in order to jump onto the bull market bandwagon. It is an "old story", but one that belongs in that class of discovery exploration stories I characterize as "rethinking the potential of a marginal system, not in terms of waiting for higher metal prices to drag a deposit into the money, but rather in terms of making a much better discovery within the system range of a past discovery that fell short of development thresholds". If we were still in the throes of a bear market I would say stand back and wait for confirmation of the bluesky. But with a market glass now switched half full, the fear of missing the boat is growing. One need only look at the success Arizona Mining Inc has had with its high grade Hermosa-Taylor zinc-lead-silver discovery beneath the Hermosa-Central silver-zinc-manganese oxide deposit on which that junior spent $40 million during the silver boom of 2009-2012 to demonstrate non-feasibility at the metal prices we ended up with after the China super-cycle ended. When the metal budget implied by an alteration system is high and not fully accounted for by what has been delineated by past risk capital, smart mining executives do not hunker down and pray for super-cycles or financial crises. They put on their geological thinking caps and go exploring for what might have been missed earlier. Serengeti is such a junior!
Kwanika was a grassroots discovery made in 2007 by Serengeti's management team led by CEO David Moore and Exploration VP Myron Osatenko. Serengeti used the new online staking system to assemble a portfolio of copper-gold prospects within the Quesnel Trough, one of which, Kwanika, had an existing low grade copper-gold porphyry deposit known as the South Zone. Serengeti conducted geophysical surveys on Kwanika which revealed a new IP chargeability anomaly in the northern part of the property. Drilling in early 2007 yielded long intersections of copper and gold mineralization with grades unusually high for British Columbia porphyries that sent the stock soaring to $4, enabling Serengeti to raise $20 million at $3 for discovery delineation. The stock subsequently crashed when it became apparent that the high grade mineralization was too deep to be open-pittable and appeared to peter out at depth, while the mineralization near surface amenable to open-pit mining was of the low grade nature that has given BC porphyry systems a bad name.
Serengeti spent $20 million and delivered a PEA in 2013 which envisioned open pit mining the upper parts of the Central and South zones, and block caving the richer part of the Central Zone for life-of-mine output of 546 million lbs copper and 489,000 oz gold. The plan targeted less than a third of the global resource: 73.7 million tonnes of 0.38% copper, 0.3 g/t gold, 1.38 g/t silver and 0.02% molybdenum with 89%, 70%, 75% and 60% recoveries for a 13.6 year mine life. CapEx was $364 million and OpEx $21.20/t at 0.95 USD per CAD. Using base case $3.63/lb Cu and $1,427/oz Au the pre-tax NPV at 5% was $263 million and IRR 13%. These numbers were so bad Serengeti did not bother calculating an after-tax NPV and IRR. The project was marginal at base case prices for copper and gold well above current levels, and even after adjusting the Canadian dollar exchange rate from near parity with the US dollar in 2013 to its current level, is still marginal today. The economic study sensitivity graph above shows that if we keep gold, silver and molybdenum at their current prices we need a fantasy price of $4.50/lb copper or better to justify developing Kwanika under the PEA scenario. My economic study does admittedly use life-of-mine averages, which makes the outcome worse than the optimized ore schedule delivers. But with the higher grade underground ore from the Central Zone not kicking in until the fifth year of a 13.6 year mine life, the PEA really was just an attempt to justify a standalone mine.
The PEA outcome sent Serengeti into the pennies. However, somebody at the trading arm of South Korea's Posco actually read the technical report and took seriously the recommendation that Kwanika could become the initial payback engine for a central milling facility that could be fed ore from other "typical" BC copper porphyry deposits yet to be discovered within a 20 km radius. Posco's trading arm, Daewoo International Corp, recognized that Serengeti owned a strategic land position in the vicinity of Kwanika, and understood that the PEA's attempt to create a standalone operation that blended low grade open-pittable ore from the Central and South Zones with block-caving of higher grade deeper Central Zone ore was a mistake. It took Serengeti almost two years to secure a deal with Daewoo, and in the process David Moore's team generated a potentially enormous bonus for Daewoo.
The market has been slow to respond because it perceives Kwanika as a recycled discard and does not believe that the future holds the sort of metal price gains created by the China super-cycle that enabled Ross Beaty to look like a genius for assembling under the Lumina umbrella marginal copper deposits found during the second half of the twentieth century. What the market has not yet realized is that Kwanika bears a similarity with the marginal open-pittable "Southern Oyu" copper deposits Robert Friedland's original Ivanhoe Mines acquired from BHP-Billiton in 2000. These deposits required a much higher copper price than prevailed at the time, something that BHP did not see coming but which Friedland did manage to get as the China super-cycle kicked in.
But where Friedland really scored big was to put his geological team to work collecting additional geophysical data for the Oyu Tolgoi system on the premise that the near surface zones did not fully account for the scale of the mineralizing system. The result was the discovery of the offset, deeper Hugo Dummett Zone in 2001 which was much richer and bigger than the "discards" BHP-Billiton handed off to Friedland, and which Rio Tinto has developed into a world class underground mine that uses block-caving.
The initial IP data at Kwanika suggested a target to the north along the Pinchi Fault which Serengeti did drill test though with disappointing results. But 3D geology and IP inversion modeling done by Serengeti during the past 3 years, which allows chargeability anomalies to be depicted in three dimensions, has revealed a substantial IP anomaly at a depth of 500 metres that juts north of the Central Zone about 1,000 m along the Pinchi Fault. Sulphides are the most likely explanation for this anomaly; the speculative question is whether or not the sulphides are enriched with copper and gold in the manner that proved to be the case at Oyu Tolgoi. The Northwest Deep IP anomaly is nowhere near as big as the Hugo Dummett Zone, but it is large enough to allow speculators to wonder if it could be part of a new class of British Columbia porphyry deposits with high grade roots such as has been observed at the Red Chris and Afton deposits.
Daewoo's basic goal is to demonstrate that the underground mineable portion of the Central Zone is richer and possibly bigger than modeled by the 2013 PEA (ie minimum 0.5% copper and 0.5 g/t gold grades), but there is a distinct possibility that north of the Central Zone and below 500 metre depth there is a substantially larger deposit (500 million tonne footprint) which, if rich enough, could turn Kwanika into a standalone block-caving operation. It is important to understand that this bluesky outcome would be a bonus for Daewoo; its decision-making has been guided by the more modest goal of upgrading the Central Zone and using it to feed a central milling facility that will send concentrates to South Korea.
Serengeti has been a bottom-fish recommendation in the past. It was a buy in the $0.10-$0.19 range in the 2009-2011 Bottom-Fish Edition during which it performed poorly while it delivered a resource estimate for the gold-copper Kwanika discovery it made in 2007, and a buy below $0.10 in the 2014-2015 Bottom-Fish Edition. Serengeti was not included in the 2016 Edition because by the end of 2015 the junior had not delivered the Kwanika farmout deal it had been negotiating with an Asian entity since mid 2014, and its financial situation had deteriorated to the point where Serengeti qualified as a zombie junior. On March 7, 2016 Seregenti finally closed a deal whereby Daewoo Intl Corp, the trading arm of South Korea's Posco giant, can earn up to 35% and certain concentrate offtake rights by spending $8.2 million over 3 years. The first year commitment is $1.2 million which includes a 2,200 m 3 hole drill program that began at the end of July 2016. This $1.2 million has already been received by Serengeti, so its balance sheet as of May 31, 2016 shows about $1 million working capital. However, $800,000 is earmarked for Kwanika exploration so that balance sheet is somewhat of an illusion. The situation improved in July when Serengeti completed a private placement led by Haywood's Tom Seltzer which raised $660,000 at $0.10 per unit, a financing that ignored Jabba the Five Year Warrant Hutt in that it included only a half warrant at $0.15 for two years, and, gasp, was priced at a premium to the Serengeti market price. Even more interesting, Seltzer's group was not part of the "pass the hat" financing of 12,020,000 units at $0.025 (with full $0.05 three year warrant) In November 2015 through which 19 parties consisting of insiders and friends coughed up $300,000 during the darkest hour of the resource sector bear market to keep a dim light burning at Serengeti. One can only hope that some of these shareholders sell some of their stock to provide the liquidity Serengeti will need to accommodate demand arising from the emerging bull market. So at this stage Serengeti does indeed have about $1 million working capital. As a bonus Dick Atkinson showed up in early August as an 11% insider when he disclosed owning 7,900,550 shares as a result of taking down 600,000 units of the private placement; he had accumulated the rest zombie fishing in the open market for Serengeti. (Atkinson is the CEO of Fjordland Explorations Inc, a zombie junior which had the acumen earlier this year to map stake the ground surrounding Canalaska's Athabasca Kimberlite Project now optioned 70% to De Beers. I suspect Atkinson may soon get to move his paintings out of the windowless converted storage office to which his Fjordland zombie was consigned last year.)
Although Serengeti has escaped the zombie dungeon, it is still exposed to financing risk, because it is possible that Daewoo, after spending $1.2 million in 2016 to earn 5%, decides in early 2017 not to proceed with the second stage whereby it can earn an additional 30% by spending $7 million in 2017 and 2018. Such a decision would not be treated kindly by the market. But that is not a real risk. Although it is not apparent in Serengeti's press releases (I discovered this through conversations with Serengeti's management), the deal with Daewoo has an unusual twist in that once it elects to continue with the option in year two, it is committed to cough up $7 million for exploration. This is not a standard grinder deal such as First Point had with Cliffs where the farm-in partner can spend several years doing nothing and then, oh shucks, admit that it will default on its spending requirement. Since the Kwanika deal was never premised on the Northwest Target, there is nothing from the 2016 program that should discourage Daewoo from electing to spend the full $8.2 million. The $800,000 earmarked for 2016 exploration will help Daewoo better understand the nature of the Central Zone which was well spelled out in the technical report for the 2013 PEA which capped gold intervals at 3 g/t and restricted the kriging radius of high grade copper intervals. During its excruciatingly long due diligence Daewoo will have risk-assessed every negative outcome; it is almost inconceivable that its decision to proceed with stage two hinges on the 3 holes Serengeti is drilling this summer. Serengeti from a distance may still look like an endangered junior, but when you look a little closer it becomes clear why it deserves a Good Relative Spec Value Buy recommendation at $0.145.
|
